Paul Premack: Millions in land calls for careful estate tax plan

Published 6:12 pm, Tuesday, January 18, 2011

Dear Mr. Premack:My wife and I own several pieces of real estate worth several million. If we convert each to community property, and put these properties into a joint trust, is the estate of each based on the total value of the trust (without regard to the individual properties) or does our estate valuation continue to be based on the individual properties? — CMU

Your potential plan is to 1) convert the land into community property, and 2) put the land into a joint trust, so that 3) you might be able to control the valuation of the land. I assume you want to control the valuation in order to reduce or eliminate estate taxes when one or both of you die. Before you carry out any part of this plan, let’s look at each facet.

First, you want to convert the land to community property (which means you think it is currently separate property). Under Texas law, for it to be separate property one of you would have (a) had to own it before your marriage began, (b) had to inherit it or receive it by gift, or (c) you may have purchased it using funds that were already your separate property. If it fits any of those categories, it is separate property, and all the value of the land is included only in the estate of the person who owns that separate property.

Converting it to community property would then have two advantages: (a) the value of the land would be split equally between your two estates – so if one of you dies, the IRS will only look at half the value as part of your estate, and (b) community property gets a free step-up in basis when one of you dies, which reduces the future capital gain taxes if the surviving spouse sells the land.

Second, you want to put the land into a joint trust. Doing so would place legal title into the hands of the Trustees, and beneficial title into the hands of the beneficiaries of your new trust. Typically, this type of trust would be revocable while you are both still alive.

Third, you want to know if the trust itself is valued as a unit or if the individual items within the trust are separately valued. The answer is that the individual items with the trust are still given discrete valuations. Putting them into a joint trust does not create a separate entity which can be valued independently. If you were to create a “family limited partnership” you might be allowed the kind of lumped-together valuation that you desire, but the IRS almost always challenges those partnership valuations (so be wary of using them).

My assumption is that you are asking these questions because you want to avoid estate taxes. If so, you need to know that the new federal estate tax law, which may expire in 2012, provides an exemption of $5 million per individual, or $10 million per married couple. If the land you own is valued at $3 or $4 million, then it is entirely exempt from estate tax if you die in 2011 or 2012. After those years, there is no way to predict the tax exemption until Congress passes another law.

One possible alternate plan: proceed with converting the land to community property, and have an experienced elder law attorney draw up a joint revocable living trust. But inside that trust, create a provision that would transfer the ½ of the land owned by the first to die into an irrevocable trust for the surviving spouse. If done correctly, that ½ will pass tax-free at the first death (up to whatever amount Congress then allows as an exemption).

The survivor’s estate would then NOT include the value placed into that irrevocable trust, so when the survivor eventually dies there will be no estate tax on that portion. Additionally, the second-to-die will have whatever exemption is allowed by Congress. This allows your land to pass to your heirs with the bare minimum in estate taxation while preserving it for your enjoyment during your lifetime.